How to Improve Your Credit in 3 Easy Steps

Today, you can obtain your credit reports and scores for free -- here's how

Just a few years ago, anyone could get credit -- and for cheap. Banks were falling over each other to sell you a mortgage, and credit card offers clogged mailboxes across the U.S. But the world has changed. Easy credit ultimately gave banks a hard time. Losses from bad mortgages piled up as the housing bubble burst. As unemployment climbed, credit card defaults jumped. Banks pulled back in response and tightened credit, which means that it's more important than ever to make sure your credit history is as pristine as possible -- not only to qualify for a new loan, but also to obtain the lowest possible rates. Luckily, knowing where you stand is relatively easy and doesn't have to cost you a penny.

Step #1: Get Your Free Credit Reports

Everyone should understand their credit history. Doing so is important for two reasons. First, by monitoring what is going on within your credit profile, you can detect fraud and identity theft -- which have become huge problems over the past decade. Second, by understanding the positive and negative credit events in your past, you can better see how to improve your credit outcomes in the future.

So how do you get the info? You've probably seen those mildly amusing commercials for services where you can sign up for a service to keep track of your credit background and score. Paying for a credit surveillance service is one way to keep an eye on your credit profile. But these services can be expensive, so they aren't for everyone. Instead, you can start by getting your credit reports for free at www.annualcreditreport.com.

If you haven't already, go to the website above. It is not a gimmick; it is not a shady website. It is the real thing. By law, each of the three major credit agencies, Equifax, Experian, and TransUnion must provide you one free credit report per year. This provides the opportunity to periodically ensure that no one has bought a car in your name, used your Social Security number to obtain a credit card, or perpetrated any other fraud that could harm your credit. It allows you to see how your credit profile evolves.

One nice aspect of the free credit report law is that you don't have to get them all at once. For example, this week, I got my Equifax report. In December, I'll get my Experian report. Then in April, I'll get my TransUnion report. If you stagger your reports, then you can check in on your credit profile every four months, instead of only once per year.

Step #2: Know Your Credit Score

Having a spotless credit report is only a part of the battle. Most lenders also consider your credit score. Even if you never miss a payment on any of your debt, however, your credit score might not be as high as another person's score. The formula is complex. It takes into account factors like the length of your credit history, how much debt you've got, what types of credit you use, and how much new credit you've applied for -- in addition to your payment history.

Getting your new score for free can be a little bit tricky. FICO, the company that computes the credit score used by most lenders, is under no legal obligation to provide it to you for free. But it has a deal at its website myfico.com where you can sign up for a trial of its credit monitoring service for free and obtain your score. If you don't want to pay for the service, just remember to cancel it before the trial ends and you will have obtained your score for free.

Sometimes, a lender will also tell you your score when you apply for a loan. For example, when buying a car, ask the salesman what your credit score is when he checks your credit. Often, they'll be happy to tell you.

In fact, recent legislation actually requires that a lender provide your credit score if the loan terms you receive are not the best possible. I spoke to FICO Consumer Operations Manager Barry Paperno about this rule that requires lenders to provide "Risk-Base Pricing Notices," which went into effect in July. He explains that even if you only receive a slightly worse interest rate than the best that a bank offers, you must be provided your credit score along with key factors that adversely affected your score.

Not everyone will learn their credit score through this new law: if you received the best credit terms offered, then the company doesn't have to provide it. But then, if you received the best credit terms possible, then you also probably don't need to worry much about your credit score!

Step #3: Understand What Your Credit Score Means and How to Improve It

Knowing your score isn't enough: you also need to have some idea of how to get it higher. The new notice just mentioned begins to help you to understand what's hurting you. But if you haven't received one of those notices, then you can still educate yourself. FICO has set up a helpful website that explains its methodology in broad strokes. So check out scoreinfo.org to learn more.

Paying close attention to your credit profile can save you thousands of dollars over the years by avoiding higher interest rates. Today, it's easier than ever to understand your credit history and score -- even for free. The only excuse for having bad credit is not being able to afford your debt. If your income is sufficient to cover your borrowing costs, then you control your credit destiny.

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation.
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Indiviglio has also written for Forbes. Prior to becoming a
journalist, he spent several years working as an investment banker and a
consultant.